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Exploring the unique nature of the Chinese onshore bond market

Since the inclusion of Chinese bonds into major global fixed income indices, we have witnessed a steady increase of international investors’ allocation into China’s US$17tn* bond market. Despite its size, China is currently under-owned, with foreign investor participation accounting for just over 3% of the entire bond market. This is about to change.

China’s recent efforts to speed up the post-pandemic recovery and internationalise the country’s bond market, coupled with consistent low correlation and attractive yields offered by Chinese bonds compared to other bond markets, represent for global investors a compelling opportunity to diversify their global portfolio.

More importantly, Chinese bonds have behaved like a safe-haven asset during times of market stress (shown in the chart below). We estimate that, over the coming 5 years, total flows into the RMB bond market could reach US$ 2trillion**.

Let’s look at how the Chinese bond market is organised and who the major players are.

China has two types of bond markets: the onshore market, which is CNY-denominated, and the offshore market, including both CNH-denominated and USD-denominated bonds.

The onshore bond market can further be divided into the China Interbank Bond Market (CIBM) and the exchange-traded bond market. 90% of all domestic bonds are traded on the CIBM, which boasts the highest trading volumes.

As illustrated below, the onshore market is more prominent, the size of it is 17 times as big as the offshore market. The onshore bond market provides greater diversification in terms of bond categories, better liquidity and a more developed market depth. As the second largest bond market in the world, it is still growing in terms of issuance, trading volume and investors, due to the ongoing local policymakers’ commitment to facilitating foreign investors’ access.

In stark contrast to most other bond markets, almost 60% of the Chinese bonds are considered “rates” products (bonds issued by governments and policy banks, hence with limited credit risk), while only 40% are “credit bonds”, bonds issued by commercial banks and corporates.

Key market segments:

Policy Bank Bonds

Policy Bank Bonds are issued by the three policy banks and are the most actively traded segment. Though not technically sovereign bonds, they are viewed as quasi-government bonds and with implicit guarantee. They provide the better liquidity among the four sectors and higher yields compared to both government bonds and local government bonds, however, they share the same international ratings as Chinese sovereigns.

Central Government Bonds (CGBs)

CGBs are, like the US Treasuries, the risk-free sovereign bonds, carrying explicit central government guarantees. Relatively liquid, up to 50Y, they represent the second most actively traded segment and are preferred by foreign investors as they initiate their exposures to Chinese bonds, especially the ultra-long end.

Local Government Bonds (LGBs)

The local government debt market is large, but fragmented, like Munis in the US. Local government bonds are the least liquid and, generally, offer slightly higher yields than government bonds, but lower yields than policy bank bonds.

Corporate Bonds

Corporate bonds, including NCDs (negotiable certificate of deposit) issued in China account for more than 40% of the market. Most of the corporate bonds are from state-owned enterprises (SOEs), and the quality and liquidity can vary.

In the next ESLJ China Insights we will look into more details on each of these segments and the different options for foreign investors to access the Chinese local bond market.

* Source - WIND as at 31st March 2021
** Source - Eurizon SLJ Capital estimations as at 31st March 2021

Disclosure

This communication is issued by Eurizon SLJ Capital Limited (“ESLJ”), a private limited company registered in England (company number: 09775525) having its registered office at 90 Queen Street, London EC4N 1SA, United Kingdom. ESLJ is authorised and regulated by the Financial Conduct Authority (FRN: 736926). This communication is treated as a marketing communication intended for professional investors only and is provided only for information purposes. It has not been prepared in accordance with legal and regulatory requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. It does not constitute research on investment matters and should not be construed as containing any recommendation, advice or suggestion, implicit or explicit, with respect to any investment strategy or financial instruments, or the issuers of any financial instruments, or a solicitation, offer or financial promotion relating to any securities or investments. ESLJ and its affiliates do not assume any liability whatsoever for the contents of this communication, save to the extent agreed in any written contract entered into between ESLJ and the recipient, and do not make any representation or warranty as to the accuracy or completeness of any information contained in this communication. Views are accurate as at the time of publication. Opinions expressed by individuals are their own and do not necessarily reflect those of ESLJ or any of its affiliates. The value of any investment may change and an investor may not get back the original amount invested. Past performance is not an indicator of future performance. This communication may not be reproduced, redistributed or copied in whole or in part for any purpose. It may not be distributed in any jurisdiction where its distribution may be restricted by law and persons into whose possession this communication comes should inform themselves about, and observe, any such restrictions.

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